This is a blog about interacting systems and how they behave: systems thinking construed broadly. Financial markets and economics; politics; and occasionally physical systems are discussed, with an attempt at focusing on how the rules of the game determine the strategies of participants and the possible outcomes.

Wednesday, 4 March 2009

The slaves revolt

There is a growing meme at the moment on the failure of academic economics. Anatole Kaletsky has a piece in the Times which reminds of the responsibility economists bear using Keynes' famous quote:

Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

He points the finger at the rational expectations and efficient market hypotheses, arguing that the impact of these two ideas has been `dire', then says:

The prevailing academic orthodoxy has to be recognised as a blind alley. Economics will have to revert to a genuine competition between diverse intellectual approaches - such as behavioural psychology, sociology, control engineering and the mathematics of chaos theory.

So economics is on the brink of a paradigm shift. We are where astronomy was when Copernicus realised that the Earth revolves around the Sun. The academic economics of the past 20 years is comparable to pre-Copernican astronomy, with its mysterious heavenly cogs, epicycles and wheels within wheels or maybe even astrology, with its faith in star signs.

For my money, this is overly optimistic. Revolution is direly needed, but there will be massive resistance to change. (One is reminded of the similar useless and career-serving complexity in string theory.)

Meanwhile Willem Buiter uses a long and persuasive FT blog to flesh out the details of the failings of macroeconomics. Buiter questions the complete markets assumption, pointing out that the characteristic issue of the crunch -- illiquidity -- cannot even be addressed once that assumption is made.

He is also particularly good on how economists have simplified their theory so that they can work with it, abandoning any hope of realism for mathematical tractability. The simplest form of uncertainty (Gaussian random walks) was assumed; equations were linearised; equilibrium was assumed. (Buiter does not dwell on the last of these, but it is very important: one of the big issues in dynamic general equilibrium models is the `e' word, given that the frequency of shocks is large compared with the relaxation time of the model.)

Buiter is scathing about the use of these models to set policy:

The practice of removing all non-linearities and most of the interesting aspects of uncertainty from the models that were then let loose on actual numerical policy analysis, was a major step backwards.

The final nail is added by The Financial Crisis and the Systemic Failure of Academic Economics, a paper by David Colander et al. (Link via debtdeflation.com.) This goes over the same themes, stressing the need for someone, somewhere, to do some work on macro models which are useful for making policy. Perhaps academic economists are not actually the right people to do this - it may be that the Copernican revolution in economics comes from the theory of complex dynamical systems (the bastard son of chaos theory) or systems biology. Perhaps we will see a new experimentalism, with models being built which actually capture aspects of the economy, rather than aspects of economic theory. But certainly there is a huge problem waiting to be solved, and there should be kudos for anyone who can make a significant contribution to solving it.

Update. The New York Times has a piece on the lack of movement in academic economics so far. It isn't surprising. Change will require a reasonable number of young economists to say I am Spartacus, and that hasn't happened yet.